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February 2, 2012

Wave of New Bank Failures Predicted

More On Legal & Compliance

from The Advisor's Professional Library

The New and Improved Form ADV
Whether an RIA is describing its investment strategy in advertisements or in the new Form ADV Part 2, it is important the firm articulates material risks faced by advisory clients and avoids language that might be construed as a guarantee.

Where Are We Headed?
The ultimate compliance goal is to help ensure that everyone associated with an advisory firm acts ethically at all times. Advisors and RIAs should do the right thing, even when regulators are not looking over their shoulders.

An analysis of the nation’s FDIC-insured banks has identified 758 banks at risk of failure over the next two years. Invictus Consulting Group, which stress-tests the banks through a model that looks at data including the age of assets by loan type, says the nation’s most vulnerable banks will have to raise capital or pursue a merger strategy to avoid joining the 389 bank and thrift failures over the past two years.

The vulnerable banks tend to be smaller institutions, with average assets totaling $580 million. But Invictus’ list includes larger banks as well, particularly in New Jersey, whose 23 vulnerable institutions, a fifth of the Garden State’s banks, average $1.8 billion in assets. Louisiana’s 10 at-risk institutions are similarly large.

While the vulnerable financial institutions are geographically dispersed, Florida accounts for the lion’s share, with 72 weak banks representing about a third of the Sunshine State’s institutions. Illinois and Georgia shared the dubious distinction of overrepresentation on Invictus’ list, with 69 and 66 weak banks and thrifts, respectively. None of the banks in Alaska, Hawaii, New Hampshire or South Dakota rated as most vulnerable.

A copy of the report was unavailable at press time, but in a news release Invictus CEO Kamal Mustafa attributed the large proportion of endangered institutions to the absence of economic recovery. “As old assets roll off, they are not being replaced at the same pace by new assets coming on, which puts bank earnings and capital construction under a great deal of pressure,” he is quoted as saying.

Mustafa foresees failures occurring as borrowers exhaust their financial resources, at which point “banks’ earnings will be insufficient to sustain capital and many banks will be unable to raise enough capital. We believe there needs to be significant capital-raising for those that can, or they must engage in mergers and acquisitions.”

In a related story, TheNew York Times’ Economix blogger Simon Johnson reports that administrative innovation at the FDIC should result in the orderly failure of larger banks, those previously deemed too big to fail. That is good news, Johnson argues, since the failure of smaller retail banks have not been disruptive, while megabanks’ implied invulnerability has brought systemic risk to the global economy.

“By creating a Systemic Resolution Advisory Committee of informed outsiders and by Webcasting the deliberations of that group,” Johnson writes, the FDIC “has brought perhaps an unprecedented degree of transparency to public policy for banks.” Three former regulators, in a book to be published this month, are currently making the case that the ability to obtain information and the competence to analyze it correctly is precisely the kind of regulatory reform the global economy needs.

The new book proposes the creation of a new institution with the power to obtain information and the duty to report it, which is different but not entirely distinct from how Johnson describes the FDIC’s new committee:

“The history of American public administration is littered with examples of policy gone wrong–and actions misdirected–because informed and well-meaning critics were kept at arm’s length. Information is withheld even from other agencies. Powerful special interests work their influence; the rest of society has no effective voice. Even the most energetic Congressional oversight is unlikely to work when expert critics are kept so far from the real policy action.

Within the financial sphere, if the FDIC really manages to convince the markets that big banks can and will fail–meaning that creditors face the genuine prospect of losses–that changes everything.”